SNB holds CHF stable
Yen approaching an all-time high – countered by BoJ?
US dollar
EURUSD has been fluctuating within a narrow band of 1.48 to 1.50 in the past weeks. Although the exchange rate exceeded this value a few times, it fell back inside the band as many times. Apparently the 1.5 mark represents a psychological barrier. Maybe the imminent end of the year is also prohibitive to any positions being taken on new territory. Still, the rising number of days with EURUSD rates above 1.5 indicates increasing pressure that will probably have to go somewhere.
The most recent macro indicators showed a slow economic recovery on both sides of the Atlantic. Since the level this recovery started from is very low, it does not trigger any form of interest speculation. Before such a thing happens, the economy will have to reclaim quite a bit of ground that it lost during the crisis. The financial crisis in Dubai was causing a short-lived bout of volatility on the markets. The public company Dubai World announced that it would ask for a moratorium on its payments. The markets were afraid of a default, which triggered a worldwide chain reaction. This resulted in the appreciation of the US dollar, i.e. the recent go-to reaction in case of rising uncertainty. However, the situation calmed down quite quickly, and now it looks like Dubai World could settle for the restructuring of its debt. The reasons for the previous and expected depreciation of the US dollar have not changed. The extremely expansive monetary policy of the central bank and the massive expansion of government debt at the same time burden the confidence in the dollar, which is why it remains under pressure.
Swiss franc
The Dubai turmoil caused a strengthening of the Franc, which was probably once again interrupted by SNB interventions, bringing the EUR/CHF rate back to 1.51. The SNB, therefore, is sticking firmly to its policy of counteracting any excessive strengthening of the Franc, and has put it into effect with great success.
In the markets, rumors (that were quite exaggerated, in our opinion) appeared about SNB President Roth’s pointing to an imminent ending of the expansive monetary policy. The original citation had been: “We have observed for a few months the signs of a recovery and the impression that the [monetary policy] framework of the crisis has to be corrected soon in order to grant price stability is getting increasingly generalized. The difficulty is to define the right moment for this though.” As long as the SNB has to fight the strong Franc, we do not expect any significant changes in monetary policy and expect a sideways movement of the Franc.
Japanese yen
The Yen first broke through the 14-year high of USD/JPY 88, then the 90% bandwidth of expected currency movements (see bandwidths below). It is hard to determine what triggered this violent movement, as the 88 mark was already surpassed before the turmoil surrounding Dubai started – although this could have contributed later on. 10-year treasuries had been quite strongly correlated with the USD/JPY exchange rate (as well as the 10-year interest rate differential). Thus later on falling Treasury yields might have reinforced the strengthening. The sharp increase of October exports might have been a catalyst too. In addition, the decrease in Japanese bank loans abroad (which could be related to fewer carry trades) points to a Yen strengthening. Japan’s inflation rate was very low at -2.5% yoy, which also supports the Yen. And finally, even though the historical volatility (measuring past exchange rate movements) decreased, the implicit volatility rose quite sharply, reflecting market expectations of higher exchange rate fluctuations. This means that option prices for exchange rate movements became more expensive, possibly reflecting speculation about a Yen strengthening. In the short term, there do not appear to be many reasons for a Yen weakening, except one essential one: possible interventions. Indeed, the BoJ has held an extraordinary meeting today and decided to provide an additional funds-supplying operation (max. amount 10 Trio Yen) at a fixed rate of 0.1% for a duration of 3 months. The aim of the operation is to encourage a further decline in long-term interest rates so as to stimulate domestic demand and fight deflationary risks. As the Yen seems to be very sensitive to long-term rates as well as inflation, this might have – in addition to the greater amount of Yen available – a weakening effect on the Japanese currency. Thus, the BoJ took the first indirect step to counteract the current strengthening, even though direct FX interventions would be more effective – but these would have to be decided on be the government which is still resilient to do so (it aims to shift the focus from export oriented and weak Yen policy to a domestic demand oriented one). We expect strengthening pressures on the Yen to persist, based on low inflation rates, increasing exports, low interest rates in the US (implying little incentive for Yen Carry trades) and renewed uncertainty on the markets. These should be countered (to some extent) by the measure of the BoJ. In our opinion, an all-clear for the Yen is conditional on either direct interventions on the FX markets, or once some “normalization” of monetary policy in the US (rate hikes) and a slowdown in export growth (which has gained momentum following the crisis but should not remain so rapid going forward), are foreseeable. This should lead to exchange rates between USD/JPY 90 to 95 in the medium term.
